Has Caterpillar's Stock Become Overvalued?

Mar. 28, 2011 6:25 PM ETCaterpillar Inc. (CAT)8 Comments
John Tobey, CFA profile picture
John Tobey, CFA
Caterpillar’s (NYSE:CAT) stock is hitting new highs. That fact, by itself, is not worrisome (see “Why Caterpillar's 'High' Stock Price Shouldn't Alarm Investors”). But what about its valuation? Is that getting too high?
Certainly this comparison makes it look so:
Price/estimated earnings ratios:
2011 – Caterpillar = 17.8x; DJIA = 12.6x
2012 – Caterpillar = 13.7x; DJIA = 11.3x
So, should we avoid Caterpillar now? No. Even with the price run-up, the stock's valuation looks reasonable. Here’s the picture ...
First, it's important to classify Caterpillar correctly.
Caterpillar is a cyclical growth firm. When the economy is growing (and, for Caterpillar, that means the global economy), the company’s earnings can rise nicely. But when the economy slumps, results turn down.
Next, recognize that Caterpillar is a leading company in this economic period.
Currently, Caterpillar’s growth is excellent and could remain so for some time. It is built on a foundation the company laid previously that puts it in the right places for this economy.
(Note: There are numerous good articles and reports about what Caterpillar is up to and how the company's positioning is excellent in this economy. My focus here is on the stock's relationship to forecast earnings and whether the the valuation is too high.)
Caterpillar’s expected earnings growth:
While Caterpillar’s stock has been rising steadily, so have the company’s estimated earnings.
Click to enlarge
Caterpillar - estimated earnings
High earnings growth is projected for 2011 (47%) and 2012 (30%). In addition, each year’s forecasts keep rising (for 2010, estimates rose 132% from August 2009 to the actual report). Add to this Caterpillar’s positive statements about the company’s future, and we clearly have a leading, cyclical growth company.
A comment about using estimated earnings ...
Remember that Wall Street analysts can have differing views about a company’s future. The estimated earnings number we

This article was written by

John Tobey, CFA profile picture
I am the founder and editor of Investment Directions. My career has been managing and consulting to multi-billion dollar funds. Using the widely accepted “multi-manager” approach, I have worked with top investment managers throughout the country, gaining a high level of expertise. My career has spanned many market environments, and I have hands-on experience searching out opportunities and avoiding risks in all of them. I now devote my time to Investment Directions, with the goal of helping investors further their understanding and improve their investing skills. I am currently serving on: The AAUW Investment Advisers Committee and The City of Vista Investment Advisory Committee.

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